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Faltering Momentum
The U.S. economy continues to lose momentum despite the Federal Reserve’s use of conventional techniques and numerous experimental measures to spur growth. In the
rst half of the year, real GDP grew at only a 1.2% annual rate while real per capita GDP
increased by a minimal 0.3% annual rate. Such
increases are insufcient to raise the standard of living, which, as measured by real median household income, stands at the same level as
it did seventeen years ago (Chart 1).
Over the latest ve years ending June 30, 2014, real GDP expanded at a paltry 2.2% annual rate. In comparison, from 1791 through 1999, the growth in real GDP was 3.9% per annum. Similarly, real per capita GDP recorded a dismal 1.4% annual growth rate over the past ve years, 26% less than the long-term growth
rate. A large contributor to this remarkable
Quarterly Review and Outlook
Third Quarter 2014
downshift in economic growth was that in
1999 the combined public and private debt reached a critical range of 250%-275% of GDP. Econometric studies have shown that a
country’s growth rate will lose about 25% of its “normal experience growth rate” when this
occurs. Further, as debt relative to GDP moves above critical threshold levels, some researchers
have found the negative consequences of debt on economic activity actually worsens at a greater
rate, thus becoming non-linear. The post-1999 record is consistent with these ndings as the U.S. debt-to-GDP levels swelled to a peak as high as 360%, well above the critical level noted
in various economic studies.
In terms of growth, it looks as if the second half of 2014 will continue to follow this
slow growth pattern. Although all of the data
has not yet been reported, it appears that the year-over-year growth in real GDP for the just
ended third quarter period is unlikely to exceed
the 2.2% pace of the past ve years. Economic vigor is absent, and the nal quarter of the year
looks to be weaker than the third quarter. Poor domestic business conditions
in the U.S. are echoed in Europe and Japan. The issue for Europe is whether the economy
triple dips into recession or manages to merely
stagnate. For Japan, the question is the degree
of the erosion in economic activity. This is
for an economy where nominal GDP has been
unchanged for almost 22 years. U.S. growth is
outpacing that of Europe and Japan primarily
Real Median Household Income
annual
196719711975197919831987199119951999200320072011
40414243444546474849505152535455565758
Thousands
40414243444546474849505152535455565758
Thousands
Sources: Census Bureau. Bureau of Labor Statistics. Through 2013.
1996 levels
Decline during current expansion = 4.0%
Chart 1
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Quarterly Review and Outlook Third Quarter 2014
expenditures U.S. price indices rose by 1.5%
in the twelve months ending August of 2014.
Both of these are near the all time lows for their respective series.
The risk of outright deation in Europe with ination at such low levels, and the danger of similar developments in the U.S., should not be minimized as ination has fallen in almost every previous U.S. and European economic contraction. Lower ination is, in fact, almost as
much of a hallmark of recessions as is decreasing
real GDP. From peak-to-trough the rate of CPI ination fell by an average of slightly more than
300 basis points in and around the mild U.S.
recessions of 1990-91 and 2000-01. Starting from a much lower point, the CPI in Europe at
those same times dropped by an average of 150
basis points. Given that ination is already so minimal in both the U.S. and Europe, even the
mildest recession could put both economies in
deation. Japan’s recent quantitative easing has helped devalue its currency by 44% versus the dollar, since the 2011 lows. This import-
dependent country has therefore seen its costs
rise dramatically. This, along with higher consumption taxes, has created a current year-over-year ination rate of 3.3%. These higher
prices are an enormous drag on economic growth as incomes fail to rise commensurately. Thus
negative GDP growth will result in a continuing pattern of deation. Japan’s CPI has been zero or negative on a year-over-year basis in 16 of
the last 23 quarters.
Declining Money Velocity A Global Event
One factor that connects poor growth with the low inflation and low bond yields
evident in the U.S., Europe and Japan is that the
velocity of money (V) is falling in all three areas. because those economies carry much higher
debt-to-GDP ratios. Based on the latest available data, aggregate debt in the U.S. stands at 334%, compared with 460% in the 17 economies in the euro-currency zone and 655% in Japan. Economic research has suggested that the more advanced the debt level, the worse the economic performance, and this theory is in fact validated
by the real world data.
Falling World Wide Inflation
In this debt-constrained environment, it is not surprising that ination is receding sharply in almost every major economy, including
China. The drop in price pressures in the U.S.
and Europe is signicant, and the fall in Chinese ination to 2%, from a peak of nearly 9% in 2008, is notable.In the latest twelve months, the CPI in
the euro currency zone rose a scant 0.3% (Chart
2), the lowest since 2009, while the core CPI increased by 0.7%, near the all time lows for
the series. The yearly gain in the U.S. for both
core and overall CPI was 1.7%. Since 1958 when the core CPI came into existence, it and
the overall CPI have increased at an average
annual rate of 3.8% and 3.9%, respectively, over
200 basis points greater than the current rates. Both the overall and core personal consumption
909498'02'06'10'140%1%2%3%4%5%6%7%-1%-2%-3%0%1%2%3%4%5%6%7%-1%-2%-3%
Global Consumer Prices
y-o-y percent change, monthly
Source: Bureau of Labor Statistics, Statistical Office of the European Communities. Through September 2014. U.S. through August.
U.S. (1.7%)Euro Area (.3%)
Chart 2
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Quarterly Review and Outlook Third Quarter 2014
all three major economic areas with existing
over indebtedness. The U.S. V is higher
than European V, which in turn is higher than Japanese V. This pattern is entirely consistent since Japan is more highly indebted than Europe,
which is more highly indebted than the U.S.
Unfortunately, broad monetary conditions (M2 money growth and velocity) are deteriorating, with 2014 displaying conditions worse than at
the end of last year. The poor trend in the velocity for all three areas indicates that monetary policy
for these countries is not a factor in inuencing
economic activity in any meaningful way.
United States.
The U.S. year-over-year M2 growth has remained at about 6%, an annual
growth level that has been consistent since
2008 (Chart 3), and the velocity of money has trended downward by about 3%. In the rst half of 2014, V declined at a rate of 3.6%, but it is
still too early to tell if this represents a new V
deceleration to the downside (Chart 4).
According to the equation of exchange
(M*V=Nominal GDP), the expected growth of nominal GDP is constrained to no more than a
3% increase with velocity declining by 3% and
money supply expanding by 6%. However,
when assessing the type of debt currently being
employed (unproductive, at best) the risks are for lower growth levels. 2014 has witnessed Functionally, many things inuence V. The factors that could theoretically inuence V in at
least some minimal fashion are too numerous to
count. A key variable, however, appears to be the productivity of debt. Money and debt are
created simultaneously. If the debt produces a sustaining income stream to repay principal and
interest, then V will rise since GDP will rise by
more than the initial borrowing. If the debt is
unproductive or counterproductive, meaning that a sustaining income stream is absent, or worse the debt subtracts from future income, then V will fall. Debt utilized for the purpose of consumption or paying of interest, or debt
that is defaulted on will be either unproductive
or counterproductive, leading to a decline in V. The Nobel laureate Milton Friedman, as well as economist Irving Fisher, commented
on the causal determinants of V. Friedman thought V was stable while Fisher believed it
was variable. Presently, the evidence suggests
that Fisher’s view has prevailed. Fisher would not be at all surprised by the current impact of excessive debt since he argued in his famous
1933 paper “The Debt-Deation Theory of Great Depressions”, that falling money velocity is a symptom of extreme over-indebtedness. Tracking that theory, it is interesting to
note that velocity is below historical norms in
M2 Money Stock
annual % change
1900191019201930194019501960197019801990200020100%5%10%15%20%25%30%-5%-10%-15%-20%0%5%10%15%20%25%30%-5%-10%-15%-20%
Sources: Federal Reserve Board. Bureau of Labor Statistics;Monetary Statistics of the United States. Through September 22, 2014.
Avg. = 6.6%
Chart 3
Velocity of Money 1900-2014
Equation of Exchange: GDP(nominal) = M*V
annual
1900191019201930194019501960197019801990200020101.001.251.501.752.002.251.001.251.501.752.002.25
Sources: Federal Reserve Board; Bureau of Economic Analysis;Bureau of the Census; The Amercian Business Cycle, Gordon, Balke and Romer. Through Q2 2014.Q2 2014; V = GDP/M, GDP = 17.2 tril, M2 = 11.3 tril, V = 1.53
avg. 1900to present = 1.741918 = 2.01946 = 1.21997 = 2.2
1.53
avg. 1953 to 1983 = 1.75GDP = MB*m*V
Chart 4
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